Monday, April 15, 2013

Price = Theory + Reality

TMM are finally emerging from their Gold bear bunker, having decided two years ago that there was never ever any point in discussing the value of gold as it verged on religious resulting in a torrent of abuse from the spamchuckers that made it just not worth the bother. But this morning we have got to the point where it can't be ignored any longer as some are blaming it for moves in other assets.

Gold is back to 2011 levels and Silver has just broken through a support at 26.00 that, if you like horizontal support lines, has been the road over a sinkhole.

Anyone who has ever studied supply and demand Econ 1.0.1 will now be scratching their heads and looking for a conspiracy theory to explain away something that "shouldn't have happened" (just go and have a look at the Hero Zedger comments in any gold piece they have posted recently). At this rate the tin-foil beanie wearers will be able to afford silver ones  But isn't it the biggest no brainer that if you print money then the value an asset of limited supply against that money has to rally?

Let's pose a question to our Econ 1.0.1 class in the style of "A Question of Sport's" "what happens next" round.

Presenter - "Japan, running out of options and seeing the success of US actions, opens the taps and announces it will print an incredible amount of money, vowing never to stop until it encounters inflation. So what happens next?"

Ex sports star - "Well Jpy takes in on the chin and hits the deck and gold goes to the moon and his shorts fall off"

Presenter -  "Anyone else?"

Other ex Sports star - "Gold catches fire and runs up the pitch screaming whilst the yen crashes into the posts"

Presenter "No. Run the film and lets see what happens to gold in yen terms.."

So what's all that about then?  TMM sees it as a lovely example of how theory disconnects from price via reality, in other words - TMM's price equation of Price = Theory + Reality (P = T + R) where reality is everything that isn't in the theory.  Theory is all well and good as long as you have enough people believing in the theory, or more rightly willing to back the theory with their own money. Its all very "Bitcoin". It will go up whilst everyone believes it will go up, whether that is based in economic theory, technical analysis, or just straight forward herd mentality. But TMM like to think that the world is more complicated that Econ 1.0.1 and just as Econ is doing for Bitcoin so Econ 79.197.1 is doing for gold. No matter how much of a fixed asset it may be it is reliant on a) everyone agreeing that it is a store of value  and b) being better to hold than any other store of value, whether that is stocks, bonds, fiat cash or lumps or gallons of any other commodity.

But isn't gold an alternative currency? One of the requirements for a useable currency or money is that its value is predictable and has a low volatility. Pricing eggs in a currency that is wanging around in 10s of percents per day, whilst exciting for traders,  is not conducive to reducing risk for shopkeepers or customers. The argument that a complete transition to the newer money would eliminate the volatility relies on 2 assumptions. First that things would settle down after transmission as currency supply steadies and second that a transition would be possible whilst high volatility exists. The European transition to the Euro was accompanied with a volatility that tailed to zero in the run up. Jumping straight to a Bitcoin or gold function with the current levels of volatility would be impossible. So obtusely,  the very reason that Bitcoin (or Gold during its run up and collapse) could not replace existing currency is because of the very volatility that is responsible for its heightened visibility.

Isn't it a hedge against inflation? Well let's look at the chart below which is the US price of gold inflation adjusted.

We would imagine that a perfect hedge against inflation would see a flat line with the  odd wobble as expectations get ahead of price. The chart above shows that they are hardly small wobbles and at current levels we would need to see 100% inflation or the price drop from these levels by a half to get back to the sort of eyeballed averages of $350 inflation adjusted. If the above chart implies expectations for inflation are already to be 100% over current price then there is an awful lot of room for inflation expectations to take off before the price has to budge.
Which leads us on to think about inflation expectations again and to wonder if we are seeing something that should worry the BoJ. Just when they have unveiled their nuclear bazooka, designed to spark the living fear of inflation into its populace, are we instead seeing a general market capitulation in the inflation trade? Commodities are off everywhere. Oil is down another 2.5% on the day and linkers are doing the same. Even the ultimate measure of usd/jpy is off 2.5% from its highs. Or is it the growth trade being unwound? The growth and inflation trades are to TMM (and obviously the BoJ) much as the interaction of magnetism and electricity are to each other. They are probably bound by a single Maxwellian equation combining the two, resulting in some Fleming hand gestures. In this case, the resultant force on gold is represented by an extended middle digit.

Where is this leading us?  Corrective moves or a new phase? We have to say that our short term trading antennae are concerned that Asian time saw the biggest wash down in gold prices and Asian time zone rarely sets new direction and often sees blow off peaks or troughs. which causes us to pause before jumping in, but with Econ 1.0.1 having been taught a lesson in P=T+R we think it less likely for such trades to be as reloaded. In a way if this is either the US growth trade being lightened or the global inflation trade being lifted it is still very interesting as it is indicative of some sizable perception changes.

Our debate extends to where this leaves equities. On one hand we should have sectoral suffering as commodity producers fall but on the other hand the feedback loop of lower input prices is great for everyone elses' margins, which once again leads us back to preferring equities to much else. Having been left behind by the equity train since the start of Feb we are still hoping for a drop to buy on, hopefully that will be on a continued growth/inflation trade unwind. We do believe that ultimately policy WILL stimulate to the tipping point that will provide inflation. How do we know? Well they've told us haven't they? But that could be a long time off.

In the meantime there are a lot of 5 minute macro managers trying to reconcile  money management issues with long term theory.


Anonymous said...

whats going on with price of gold is modern day discovery of forgery. how many times outstanding claims on gold outnumber actual physical gold ? how can you know wich claim is true ? is it the share of ETF you just bought, or simply the one futures contract you ate ? aaaa.. you bought into nostro..... can they deliver ? MtRC

Saul Bollox said...

what's going on with gold, mate, is someone is selling a f***ing shedload full of it.

Anonymous said...

Bigger muppet: Jim Rickards or Peter Schiff?

Anonymous said...

C Says'
A combination of issues perhaps.
German ,I mean European policy on bailouts appears to have morphed a bit.Is the market wondering whether future bailout requests might be met with a demand that some gold reserves be sold? Supply fundamentals would be under pressure especially were that to occur in a world where low growth recovery left you wondering who needs an hedge.Leading indicator for such a world is surely going to be Chinese data.
Indeed one wonders if the Chinese are now catching the US bug where the bang for buck of monetary policy on economic activity becomes increasingly smaller. Now where would that leave our little Japanese friends.

Leftback said...

Given that Mr Bond is bid, and Gold is being offered the finger*, we would hazard to say that US inflation and growth expectations are being revised downwards due to soft demand and slack labor markets. It's not really that complicated, is it?

In other words, it's not so Peter Schiff today, it's a bit more Gary Shilling.

*(ht: "The Original")

Primate Trader said...

Monkey didn't get a pellet today. Beginning to wonder about the pellet machine.

Expect a lot of lever pressing later this afternoon.

Anonymous said...

LB, I wouldnt extrapolate too quickly.

It could be inflation expectations lower ...

... but it could also simply be macro toddlers looking for a way out in a market way thinner than they had expected (i.e. what if great rotation™ was "out of commodities into stocks").

Lots of people own the shiny metals for wrong reasons. This could simply be the unwind of asset class overreach for the Paulhorns.

Primate Trader, agreed. Interesting day for margin clerks, for sure.

- DD

Leftback said...

Agreed, DD.

Who indeed? Who would make bigger dumber over-reaching macro punts than the Paulhorns? After all you have to have a bit of a simplistic world view to rake in billions of $AUM, right? You don't attract so many punters with a X= (nuanced) f(DVY + LQD) strategy...

What a shocker to find that the spot gold market can get a bit thin? But when big funds bleed, there is usually a fair amount of blood in the water, so don't be surprised to see some Great Whites circling the Monkey boats looking for a quick feed.

Jury still out on inflation. But it is ultimately driven by wages and that just ain't happening in the US. Turning Japanese, until further notice. Domo arigato...

Anonymous said...

Currency debasement? Or Gold in de basement?

Monkey must be getting a bit irritated by now, he's been pressing the lever all day and hasn't gotten a decent pellet.

Anonymous said...

Gold is not and never was an "inflation hedge".

Leftback said...

AUDUSD (also EUR and CAD) went South notably just after 2pm. Obviously, ZAR hasn't been the place to be today. Ladies and gentlemen, we appear to have a little bit of an unwind of leveraged carry trades. This usually goes on for a few days once it gets rolling.....

Today's rally attempts have averaged only 3 pts on the Spoos. No really strong technical support until the 1530-1550 zone. The 1540 level stands out.

Anonymous said...

C Says'
You see Grandmum Angela says',
"we do not have the strength for a second economic package without losing international confidence".

Now imo there is a clear signal from her (at least until the election) that any further problems get solved 'inhouse' and that menas any further upheaval in Europe this summer doesn't come with the kind of intervention safety net anyone might rely on especially on margin.

Actually looking at the % reserves held in gold in some of those European countries I have to say she may have a point.

Ruck formed !!

Anonymous said...

Wait a minute, isn't it the potential Fed's QE exit that got the gold market worried first place?

Firm US growth data merely strengthens the view that Fed just might start exiting QE and that may lead to assets that rallied during QE, including gold, to dump.

Weak data might just extend the view that QE will live on, and that maybe better for gold and commodities.

Polemic said...

Oh God .. Boston

Leftback said...

.... and just like that, the under-performance YTD was erased in a single trading day. ... (exhales) ...

Took off a LOT of directionality today. The last few days we have been feeling like our family jewels are resting in the guillotine, awaiting the executioner, so it feels very good to reduce risk ahead of April expiration.

We had an absolutely massive day on the short side today, mainly courtesy of a 5% drop in our beloved homebuilder ETF XHB and another favorite, FB.

We do fancy these FX moves to follow through into Asian trading and DX to push higher tomorrow. AUD and CAD, you can go lower !!!

Leftback said...

Ugh. Just returning to reality. Hope this isn't as bad as it looks.

Brings back vivid memories of the bombing campaign in the early 80s, that seemed to follow me across London, always missing me by 400 yards. Was on a bus half a mile away when Harrods went up.DB

Anonymous said...

Godspeed Boston.


Leftback said...

Bombs in the rubbish bins. That's why London didn't have any on the streets for years and years. Horrible.

abee crombie said...

sympathies to boston.

Onto Gold. Interesting points about the volatility of gold being too high for conventional currency. I do agree there. But that is more of a function of the current marginal holders of gold, IMO

Gold has had one of the most fantastic bull market runs over the past 13 years, so it is natural to expect a large correction at some point, as expectations start diverging from reality and the momo crowd gets tired.

But the true gnomes of zurich are out there salivating for prices for go lower. There is clear panic in the miner shares as well, which has been a busted trade for too long but at some point will bounce hard.

I'm dipping my toe in. Sure it could be early, and I hope it is so. But in a world where 3x cap rates are justified on REITs and 25x earnings on 'core brands' with 5% growth, owning Gold is not a high opportunity cost. The vol is high yes, and therefore portfolio variance chumps will dump it. But I have a feeling that in 5-10 years Gold will trade with negative correlation to risk assets (just like bonds in the 80's)

Lykean Capital said...

Nico G said...

has anyone mentioned the stupid leverage on gold futures - this exacerbated the upmove, only fair it makes it spicy when all look at the exit door. Wow i said something really new today

to note: the (relative) bid on European equity futures when ES accelerated down. Someone is looking for an (already clubbed) hedge.

Anonymous said...

C Says
I'd be surprised if you're alone in sifting the wreckage.Huge moves leave vacuums to be filled and ocver buying does that job.

Some big earnings today as well.

Broadly the BP's though are below the 50MA except for the NDX which is holding on.The others though are curling over indicating decreasing number of outright longs and overhead price resistance now forming up.

Not inconceivable that this action resolves into fairly modest consolidation.It happens,but to do so means earnings must be solid and no more nasty surprises.The other option of cousre is for something much deeper running into mid year.
The market struggles to advance though until these BP's workout their stuff and we're not yet in that vicinity.

No surprise we are in THAT week of the month again. Best guess is just expect yet more volatility ahead.Speaking of which China this weekend will be a watch because so much appear to be riding on them. Anyone look at the recent sales forecasts from Alcoa? If they did they would see clearly Alcoa was virtually totally dependent on growth in that country.Most other areas were either contracting (inc US) ,or flat.That's an awful setup being far too concentrated for comfort.

Anonymous said...

Great post TMM, really brought a smile to my face, love the geeky references re fingering fleming (right or left hand tho?) and the home vs german IPs.
Interestingly, despite all the yennish talk of jap real money rushing out I cannot find a single dealer who can testify to having seen any real flows, so all the bull flattening and -10bp in xccy basis is simply front running...
That was also the only meaningful exit chatter I heard on this move too - Paulhorn and some front-running. Noticeable that a few houses changed their gold calls in the last 2 weeks (think I counted 4 major IBs).
Keep up the good work guys, I'm off to get smelly fingers in jgbs.
All the best from a loyal reader,

WellRed said...

Thinking back to the last, sharp directional move in a a precious metal (silver dropping from $49) that trade started in Asia on a Sunday night.

Just to be that annoying guy.

Polemic said...

Oh Wellred .. well annoying spotted! OKOKOK.. we ll amend our rue not to apply to PM's

Well red sir